The Spectre of Default

Governments the world over are hoping to publicly borrow their way out of the stupendous mess created by the private financial sector. They are thus engaging in a monetary and fiscal experiment of Titanic proportions, steering a patchwork ship of State constructed from traditional Keynesianism and radical free-market ideology. Unfortunately, they are either blind to, or are nervously whistling past, the largest iceberg field in the history of economic navigation.

We are not going to escape unscathed.

Let's quickly set out what went wrong: oceans of debt blew asset bubbles for everything from clapboard houses and dinky mortgages to smelly shares, hedge funds, LBOs and 2/20 private equity funds. If an "asset" as much as fogged the mirror it was sliced, diced, indexed and leveraged to the hilt, transformed into a creative financial "product". A private banker friend told me two years ago that his nouveau riches customers from as far afield as Bangalore, Dubai, Sao Paolo and Moscow cared about one thing and one thing only: how many times can I leverage this baby up? At the top, if the answer was less than 40-fold they just sniffled and turned their noses away. (That's 97.5% margin, in case you were wondering..).

What happened next, predictably enough, was a debt crisis of historic proportions - and it's still going on. Amazing isn't it, how the newest generation of suckers always jump with glee into the oldest trap in the world* ?

Debt In The Yihaa !! Era

Governments, particularly in the U.S., are now desperately trying to avoid their biggest bugaboo: persistent asset deflation through debt destruction. Why? Because most assets are held by that tiny minority of the population for whom the golden rule applies (he who who owns the "gold" makes the rules). The vast majority of the rest have debts. To get a sense of the vast divide, in 2007 half of all American families had a net worth of $58,000 or less. By contrast, the top 10% had a net worth of $4,000,000 on average.

Chart: Federal Reserve

For a pluralistic republic like the U.S., does it make any sense to salvage the top 5-10% of the population's assets by placing more debt on the shoulders of everyone else - who already own next to nothing? Would it not be better to work out a debt default and reduction plan, instead of pumping the debt bubble even bigger?

But, mention debt default by (intelligent) design during a polite conversation and watch it grow hot and indignant - that's the moralistic Protestant Ethic weaving through most of us, I guess. Putting it another way, the Spectre of Default haunts, increasingly with as much fear as the other one did, back in 1848.

I am starting to believe that what America ultimately needs is a modern-day Solon and a healthy dose of seisachtheia.

___________________________________________

* A short aside about the benefits of a comprehensive education in financial history: an acquaintance just told me he is convinced the economy is on a solid rebound track. When asked how he came to this conclusion, he proudly assured me had taken one (1) year of economics at college, some 20 years ago. Yes, indeed, there's one born every minute... So, at least, read a bunch of books before sententious certainty sets in, eh?